When your cow gets bigger but produces less milk, it’s usually time to worry that something has gone wrong with the beast. That’s the first thing that came to my mind when I heard that the Federal Reserve — a cash cow for U.S. taxpayers ever since the worldwide financial bailout began five years ago — sent less money to the Treasury last year than in 2012. This despite the fact that the Fed had increased its securities holdings by about $1.1 trillion.
The Fed announced Friday that it sent about $77.7 billion to the Treasury last year, down from $88.4 billion in 2012. This means that the Fed has sent the Treasury (and thus U.S. taxpayers) a total of $367 billion over the past five years, compared with the approximately $150 billion it would have likely sent had it not made massive securities purchases in an attempt to force down interest rates. Think of this extra $200 billion-plus as taxpayer revenue generated by the bailout of the financial system.
The Fed doesn’t send all this money to the Treasury to be nice. It’s required to turn over essentially all its profits to the Treasury, which counts them — quite properly — as revenue, the same way it counts your income tax payments.
To continue milking my metaphor, what accounts for the Fed sending substantially less money to the Treasury last year than in 2012? Has the Fed been chowing down on inferior fodder? Nope.
What happened is that in 2012, the Fed made some nifty one-time profits as a result of its bailout activities. That didn’t happen last year.
In 2012, the Fed sold most of the once-toxic securities it acquired in 2008 from Bear Stearns and AIG as part of the federal bailout of those firms’ creditors. It made a $6.1 billion profit on these securities, which it bought at distressed prices during the financial meltdown and sold into a recovered, yield-hungry market.
In addition, the Fed realized $13.3 billion of profits by selling shorter-term securities in its portfolio in order to raise money to reinvest in longer-term securities, a move called Operation Twist.
These one-time profits, offset by currency losses, totaled $18.5 billion in 2012. That’s why the Fed earned $90.1 billion in 2012 but only $79.5 billion last year, when it got only $143 million from the remnants of its Bear and AIG holdings. Adjust for the one-time gains, and the Fed’s profits were up about 10 percent.
I suspect that the Fed’s announcement will trigger the usual discussions about the huge risks the Fed is running by holding $3.8 trillion of securities, many of them long-term, whose market value will continue falling as interest rates continue rising.
Critics will say this decline could well wipe out the Fed’s capital. But guess what? That won’t happen, thanks to a little-noticed accounting change the Fed adopted in 2011. I learned about it this week from Ray Stone of the Fed-watching firm of Smith McCarthy Research Associates, and I don’t think that many people realize it exists.
The rule allows the Fed to avoid having to mark down the value of securities that it intends to hold. That lets the Fed sit, collect interest on the securities, wait for them to mature, and then collect their full face value. Regular banks can’t make up their own accounting rules, but our central bank can.
This rule points to a key difference between the Fed and the Swiss National Bank, which recently took a huge writedown in the value of its gold reserves and stopped paying dividends. Unlike the securities that the Fed owns, gold doesn’t pay interest and isn’t guaranteed to pay off at a certain value on a certain date. That’s why the writedown and dividend cessation by the Swiss bank don’t make me worry about the Fed’s financial soundness.
One final note. At some point — I hope soon — short-term interest rates will rise above 4 percent. That will put a big damper on the Fed’s profits, possibly even generating losses. At the very least, the Fed will send far less money to the Treasury than it has been sending.
You can bet that this will generate political pressure to increase oversight of the Fed. Giving in to that pressure will be a huge mistake. Whatever you think of the Fed — and I’m no fan — it’s been able to do its job as it sees fit without having to get clearance from the dysfunctional political system. It’s functioned far better than the rest of the government. Forcing the Fed to have to beg Congress for money would subject it to dysfunction, which is the last thing we need.
Even if Fed remittances stop for a year or two, we shouldn’t get too upset with the old cash cow. We should remember that taxpayers got to skim the cream off the Fed’s securities portfolio when the Treasury really needed the money. Nuff said.
Sloan is Fortune magazine’s senior editor at large.